We check in with KBRA a year after its European launch to talk about the global captive market, its first 12 months in Europe, and its customer service-based approach
We check in with KBRA a year after its European launch to talk about the global captive market, its first 12 months in Europe, and its customer service-based approach
What captive trends have you seen this year?
Carol Pierce: There is still interest in captive formations, but in the US the formations tend to be among small- and middle-market-sized enterprises. Occasionally, a publicly traded company sets one up, but I would say that is not as prevalent as it was 15 to 20 years ago when there were more traded companies forming captives. The industry has expanded and a different level of company is forming and benefiting from owning a captive.
That said, in terms of ratings and why captives seek ratings, the current market is no different from the past. On the multi-owner captive side, they seek a rating to get validation in the market because they’re competing for members against commercial companies that all carry ratings—that hasn’t changed.
In terms of single parent captives, what we are seeing is that they seek ratings for specific reasons. They either have a customer contract that requires a rating, or they have a specific reinsurance arrangement that requires them to have a rating. That is primarily where we are seeing interest at the moment. The interest is not broad and the single-parent captives do not seek ratings like multi-owner captives or like commercial companies do. Just as a captive is formed for a very specific risk management reason, ratings are sought for very specific business needs.
What are the key factors in the rating process?
Pierce: When we put the KBRA captive rating methodology together we wanted to make it hand-in-glove with our existing insurance methodologies for commercial companies. We made a well-defined split between companies to be rated under the captive methodology and companies to be rated under the global insurer methodology, so there would be no confusion in the market. Also, as some captives have evolved into commercial companies over the years, it enables us to move a company between methodologies without too much disruption. I think that is a real key to how we set the whole thing up.
We do fundamental and technical financial analysis, but we don’t have a proprietary capital model that we are using in any of the insurance sectors. We do stress testing, and our methodologies tend to look at qualitative and quantitative components equally. In the case of a startup, the qualitative aspects are key. In terms of the qualitative factors, we don’t have a bias against some of the types of assets that captives would own, for example, letters of credits and loan-backs.
Obviously, we do a lot of due diligence on the credit quality of whatever types of assets are owned. As captives generally are not profit orientated we look at profitability as a cost of risk metric, rather than on an underwriting profitability basis. We expect the captive to charge enough money to breakeven, but we do not expect captives to be profit centres within their organisational structures. However, they do need to provide value to their owners and cost of risk is probably a better metric for measuring that.
We do a formal assessment of the owners as part of the rating process. For group captives we look at their by-laws to see what additional capital they can access if it’s needed. In the case of single-parent captives, we have a corporates team that does the analysis on the parent company, but that assessment is not a ratings ceiling for the captive insurance company; it is just one of many things that we look at as we come up with a rating and that goes for sovereign risk as well.
Sovereign ratings apply to the debt of the country and are not ratings on the country itself; therefore, they also do not act as a ceiling on the financial strength ratings for captives.
What was the motivation behind setting up KBRA’s European office and what have you been up to?
Mauricio Noé: We received our registration from the regulator, the European Securities and Markets Authority (ESMA), almost exactly a year ago and that is really when the gun was fired in terms of us going after business in Europe. We decided to come to Europe now because we started reaching saturation point in a few markets in the US–which is a high class problem to have as you can imagine. What we were looking to do was expand.
The ratings business was mostly dominated by a few very large players whose market share appeared somewhat unaffected by the crisis. It was deemed that setting up a new rating agency in Europe was a good idea, as it was for us in the US eight years ago.
We have been here now for a year and have made enormous progress. We have rated a number of deals, most of them private, but a few fairly high profile public transactions in the asset-backed securities, residential mortgage-backed securities and commercial mortgage-backed securities space. Issuers and investors alike are very keen to see us and there is an enormous amount of goodwill being directed towards us. I feel that we are really at the start of something meaningful in terms of disrupting the ratings business.
What are you expecting to be the impact of Brexit?
Noé: Being headquartered in Dublin was mostly a Brexit-related decision. We are regulated centrally by ESMA in Paris, there is no local regulatory oversight like an insurance company or a bank might have. So, we needed to be in the EU 27 when we set up our business.
We eagerly await the outcome of the Brexit negotiations but we will be opening a UK regulated entity as well post-Brexit, irrespective of the flavour of Brexit that emerges.
The soon-to-be regulator in the UK, the Financial Conduct Authority (FCA), is incredibly pragmatic and business-minded. They are very keen to avoid any interruption of regulatory capital treatment that our ratings afford to investors. That is a really important consideration–if you are a UK insurance company and you are using our ratings for your regulatory capital treatment, the FCA is determined to ensure there is not a moment’s gap in coverage and impact on balance sheets as a result, which is a good thing.
We aren’t expecting Brexit to have a specific impact on ratings. We rate the UK itself and so publicly discuss Brexit and the implications on the UK economy.
I think the number of ratings we issue in the UK will be entirely correlated to the strength of the UK economy in terms of the number of banks and securities being issued. We don’t really see it having a huge amount of difference. Specific risks to the UK economy are detailed in our rating of the UK where we have a negative outlook because of Brexit.
Did you set targets up for your first year? And have you achieved those targets?
Noé: Yes, we certainly have. Our targets are numerous, they don’t just relate to the number of transactions. Our goal is to spread the word and really evangelise our business and the need for a disruptive force in the ratings business and that was really our goal in the first year.
We got that message across and are virally affecting the market and making people realise that there is another approach. There are firms out there like us that are putting customer service first we realise in the long term that is the way to build a sustainable business.
Giles O’Flynn: I joined KBRA in June this year, having been at Moody’s for 20 years, and it has been exciting to join a smaller company that focuses on customer service, being nimble and responsive to issuers, bankers and investors. The market welcomes another agency and competitor because for a long time it has been dominated by two or three big firms and people want more choice.
Does having a range of experience from staff who witnessed the crisis in 2008 give you an advantage in seeing how things should be done now?
Noé: Yes. It gives us perspective, it gives us the ability to look at the cycle over the long term not just based on short term, idiosyncratic events. Our goal is, for example, on the ratings side, not to react in a knee jerk manner either downgrading or upgrading, we try to look to the long term and have a smooth trajectory rather than a cliff edge.
So, if a business is going badly it will be a gradual process, if it is going well it will be a gradual process. Too often we see a cliff effect, usually on the way down. It is just a case of trying to have some perspective, have a long term view on the market and providing all of our stakeholders with something that is useful to them. Saying a rating is one thing one day and one thing the very next day, is not really offering anyone much value.
Essentially what we are trying to do is provide our issuers, investors, regulators and all market participants a product that is useful to all of them and reflects the creditworthiness of an issuer or an asset in real time.
What are the plans from KBRA in the European market moving forward?
Noé: We are shifting gears and starting to rate all the asset classes that we hope to rate, and become a full service rating agency over here as we are in the US.
Our targets are about penetration of the market by winning over the hearts and minds of our stakeholders because that is how you build a long term sustainable business. Given that we have a strong platform in the US we are looking to replicate that.
O’Flynn: We are well known in the US with significant market shares in certain asset classes, and our model is to replicate our expertise and focus in the US to Europe and build upon that as a strong base to in time rate other asset classes.
The good news is that investors are familiar with KBRA in Europe based on KBRA’s achievements in the US in a short space of time and that is a great springboard.
